Program Links Loans to Future Earnings

Daniel Toole is a 28-year-old architect in Seattle who plans to attend Harvard’s master’s program in urban design. But instead of paying his way with graduate student loans, he is trying to raise money by selling a slice of his future earnings to investors.

He needs $80,000, even after scholarships and grants. Mr. Toole wants to finance a big chunk of that through a new company called Pave, which connects people like him with “backers.” If he reaches his goal and raises $30,000 from Pave investors, he will pay them 7 percent of his projected annual salary for 10 years.

“If I decide to go into the Peace Corps or do something like work for a major firm that didn’t pay well for the first couple years out of school, the percentage of total income would be quite a bit lower than standard 10-year loan paybacks,” said Mr. Toole, who has commitments for nearly $11,000 so far.

The program comes with other perks: the investors, who clearly want to see their human investments succeed, often double as mentors.

“This is me reaching out and seeing if I can get access to people who can guide me through my career and push me around through their own networks,” Mr. Toole added. “I need solid financial mentorship. I am not great with money, and my parents cannot provide that for me.”

This alternative form of financing is unlikely to put even a tiny dent in the vast market for federal and private student loans. But with student debt approaching more than $1.2 trillion, particularly at a time when young graduates are facing high unemployment, it’s not that surprising that some people find the idea alluring. Viewed through another prism, critics call it a form of indentured servitude.

The program enrollees I spoke with found the whole idea liberating. They said they preferred to pay back a living being who took a risk instead of a faceless institution; it felt less like a loan, they said, and more like an opportunity. If a borrower wants to take a year to start a new company, for instance, or their income drops below, say, the poverty level, they aren’t required to make payments. The risk is shouldered by the investor.

The whole notion of using a portion of your future income to pay for higher education recently made headlines in Oregon. The state Legislature there approved a bill that would create a pilot program: instead of tuition, all students enrolled in state colleges would pay, say, 3 percent of their future income for about 20 years into a state-administered fund. That means some would pay more for their education than others; the program’s supporters say people should think about it as a social insurance program, like Social Security.

Pave and its competitors, including a company called Upstart, operate differently. Upstart, for instance, tries to estimate what you are likely to earn, based on factors including the college attended, the field of study and grade point average, among other things. “Harvard M.B.A.’s have a very high earning potential,” said Dave Girouard, the founder of Upstart and a former Google executive, “and that means they can raise more money for a lower portion of income.”

Among its small crop of first users, individuals have raised about $25,000 on average, though Rachel Honeth Kim, a Harvard graduate with an M.B.A., recently raised $100,000 from 37 investors, including Mr. Girouard.

Many of the people enrolled with companies like Pave and Upstart use the money to finance their own companies and ideas, or, like Mr. Toole, to further their education or pay off existing student debt. A freshman seeking to bankroll an entire college education isn’t the type of candidate these sites are seeking, at least not now.

The companies are also ushering the most promising candidates onto their programs, often with big entrepreneurial plans or causes that are likely to catch investors’ attention. But nobody is guaranteed to raise enough money to meet their goals.

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Daniel Toole, 28, an architect in Seattle, is trying to raise $30,000 through Pave so he can seek a master’s degree at Harvard.CreditStuart Isett for The New York Times

There are other risks, too. If a person is wildly or even moderately successful, they may pay far more than they would owe using a traditional loan. And people with big dreams in lower-paying professions may not necessarily raise enough to cover their education costs.

Of course, if borrowers have enough income to pay their obligations but fail to, the whole experience will begin to feel more like a traditional loan. Delinquencies will be reported to the big credit bureaus. Collection agencies will get involved. (Borrowers will be held to their contracts. Pave and Upstart also had discussions with the Consumer Financial Protection Bureau, a federal regulator that oversees financial products and services.)

Participants in these programs also need to figure out whether they would fare better using federal student loans and programs. Some graduates with high debt loads relative to their income can reduce those payments using one of the federal government’s income-based repayment programs, which caps payments at 10 to 15 percent of income and discharges remaining debt after 20 or 25 years. Public service and nonprofit workers may be eligible to have any remaining debt discharged after 10 years of payments.

Keeping all of that in mind, here’s a closer look at how some of these companies work.

PAVE You must be 18 to join, but the company said there was greater demand for people who were at least in their senior year of college. Given those demographics, close to half the people are using the money raised to repay debt, while others are using the money to pursue a big idea like making films or to further their education. Once the company verifies that individuals are who they say they are, and they pass its financial and credit check, they may create a video campaign and online pitch.

Sal Lahoud, one of Pave’s co-founders, said it used historical guidance based on what the average person had earned in a particular field to estimate a candidate’s future income, which helped it determine how much they were likely to raise successfully. It’s ultimately up to the prospects to decide what percentage of their earnings they are comfortable signing away for the next 10 years, though it can be no more than 10 percent of their annual income.

There is no cap on the amount repaid to investors, but prospects can always decide to pay their backers five times the original amount, unless other terms are set. “If you are doing amazing, why should the people who invested in you early on not participate?” Mr. Lahoud asked. “We built a contract that balances both sides very well. The investors take full downside and full upside.”

Pave takes its share, too: 3 percent of the amount the individual raises, and it charges a 1.5 percent servicing fee on payments made to the investors, who are estimated to earn about 5 to 8 percent on their investment.

So far, more than 4,000 prospects have applied to the program, with more than 1,000 backers. But the service opened to the public only six weeks ago. About 30 people have either received all of their funding or are still currently raising money, for a grand total of $550,000. About 130 more prospects have been invited to start campaigns, which will be introduced on the Web site over the next few months.

UPSTART Though the company plans on opening the program to more people, right now it’s accessible only to college seniors and people who graduated from a four-year college or a graduate program within the last eight years. You also need to be in reasonably good shape creditwise, meaning you need a FICO score of at least 640. (Having no credit history is acceptable).

The maximum candidates can share is 7 percent of their projected annual income (over 10 years), which is calculated using its own model.

As with Pave, there’s nothing stopping a potential high-earner from changing course and deciding to become a social worker or a teacher. That’s the risk the investor takes, though Mr. Girouard says they aim to generate investor returns of about 8 percent on average. (My colleague Paul Sullivan wrote about them from the investor’s perspective last month).

People earning less than $30,000 annually are not required to make payments, but the repayment term extends a year. The maximum they can ever pay back is five times the amount raised.

The company collects 3 percent of the money raised, and it charges investors an annual fee of 0.50 percent of the amount invested, not unlike a mutual fund. Both Pave and Upstart allow only accredited investors to participate, which means having an annual income more than $200,000 or a net worth above $1 million.

LUMNIThis company, which in 2002 helped bankroll its first student in Chile, is open to all college students, though it aims to help those from lower-income families. Investors ultimately decide which students they want to finance. As at the other sites, students also agree to pay back a set percentage of their projected future income to their investors — a maximum of 15 percent in the United States — for up to 120 months after they graduate. Lumni, which started operating in the United States in 2010, has helped 27 students raise money here (and more than 3,000 in Chile, Peru, Mexico and Colombia). It’s not accepting new applications from American students right now because it is currently analyzing how its first crop of graduates performed. “We see our relationship more like the one angel investors have with entrepreneurs,” said Felipe Vergara, the company’s chief executive.

A version of this article appears in print on , Section B, Page 1 of the New York edition with the headline: Frayed Prospects,
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